Managing Fiduciary Risk when providing Poverty Reduction Budget Support

How to note 22 SEPTEMBER 2004 Managing Fiduciary Risk when providing Poverty Reduction Budget Support Introduction What is the purpose of this note? 1. DFID s policy on managing fiduciary risk sets out a recommended approach rather than an exact set of instructions. This is outlined in the document, Managing Fiduciary Risk when providing Direct Budget Support (2002), and has been agreed with the National Audit Office. 2. This How to Note provides operational guidance on how to implement this approach and is targeted towards country office staff involved in fiduciary risk assessments and Public Financial Management and Accountability (PFMA) reform programmes. This note does not set out new policy, rather it aims to promote a consistent approach across DFID to fiduciary risk assessments and to ensure that these assessments are clearly presented and justified with reasonable evidence. It provides country offices with detailed practical guidance without dictating a prescribed checklist of directives. The exact scope of any fiduciary risk assessment will depend on specific country context. 3. This guidance has been prepared following a lengthy consultation process, drawing on recent fiduciary risk assessments and incorporating substantial feedback from country offices. We have also reflected comments from the National Audit Office. This note will be updated on a periodic basis and a library of recent fiduciary risk assessments will be maintained on the Policy Division PFMA team Insight webpage. This library will include short summary boxes to guide users towards relevant case study examples and lessons learnt to date. 4. A shorter Briefing Note is also available giving an overview of essential information. For further information please contact the PFMA team at pfma@dfid.gov.uk Page 1 of 34

What are the key messages in this note? 5. Five key messages underpin DFID s approach to managing fiduciary risk: i. A mandatory section on fiduciary risk assessment, including an evaluation of the risk of corruption, should be included in all PRBS submissions. ii. iii. iv. Fiduciary risk assessments are subject to a light and proportionate central support and scrutiny process led by Finance and Corporate Performance Division. This will strengthen consistency of approach across DFID and check that judgements presented are supported by reasonable evidence. Responsibility for judgements made will remain with the relevant spending division. High fiduciary risk does not necessarily preclude the provision of PRBS; what is critical is that such risk is thoroughly evaluated and clearly presented. DFID does not require partner countries to meet a minimum standard of public financial management performance for the provision of PRBS. Rather, the government must provide evidence of a credible programme to improve its PFMA performance. v. DFID promotes a harmonised approach to managing fiduciary risk. Where appropriate, we encourage fiduciary risk assessments to be carried out jointly with partner governments and other donors, ideally building on partner government s own analysis. How is this note structured? 6. The key areas of guidance in this How to Note are: Evaluation: (Pages 6-10) This section provides guidance on how to perform a thorough evaluation of partner countries PFMA systems and associated risks (including the risk of corruption). Annex 1 details the 8 good practice principles and 15 related benchmarks set out in the 2002 policy and suggests a set of questions to help assess how far these have been met. Credible Programme of Improvement: (Pages 11-13) This section provides guidance on how to assess whether a programme of PFMA improvement is credible, including a judgement as to whether reforms will be implemented. Annex 2 suggests a set of questions to assist this judgement. Decision-making: (Pages 14-19) This final section provides guidance on how to record a fiduciary risk assessment and ensure that judgements are clearly stated and based on reasonable and consistent evidence. This includes an explanation of the central support and scrutiny process. Page 2 of 34

What are the key operational implications of DFID s policy? 7. Table 1 provides a summary of DFID s current policy on managing fiduciary and an overview of the key operational implications detailed in this guidance: Table 1: Overall Approach to Managing Fiduciary Risk DFID Policy: 1 Evaluation A thorough evaluation of PFMA systems and associated risks (including procurement and corruption) should be carried out. 2 Credible Programme to Improve The government should have a credible programme to improve standards of these systems. 3 Developmental Benefits should justify Risk Key Operational Implications: Promote a harmonised approach Focus on existing partner country information & diagnostic studies Identify key fiduciary risks against current good practice principles and benchmarks Address related risk of corruption Understand the governance & institutional context Provide summary of PFMA reform initiatives and related programmes (e.g. Anti-Corruption, Public Sector, Local Government) Assess whether there is a credible programme of improvement Assess whether short-term safeguards are required Detail mechanisms for monitoring fiduciary risk and measuring progress in PFMA systems (An analysis of the potential developmental benefits is outside the scope of this note) 4 Decision-Making The assessment should be explicitly recorded as part of the decision-making process Keep a complete audit trail and provide bibliography of information used Complete a fiduciary risk assessment; recommended content includes: judgement on overall risk, statement on key risks including corruption and statement on whether there is a credible programme of improvement Ensure adequate evidence is presented to support fiduciary risk judgements Consult with both the Finance and Corporate Performance Division and Policy Division Page 3 of 34

Navigating this note 8. The following table of contents has been included to help users navigate this How to Note. When viewing this document electronically, double click on a heading listed below for easy reference. Introduction... 1 Definitions...4 Evaluation...6 Harmonised Approaches... 6 What information is required?... 7 Where is information obtained from?... 9 Credible Programme of Improvement... 11 What is a credible programme to improve?... 11 Which safeguards are appropriate for what risks?... 12 How can risks be effectively monitored and progress evaluated?... 13 Decision Making... 14 Audit Trail and Record of Information Sources... 14 How should a Fiduciary Risk Assessment be recorded?... 14 Central Support & Scrutiny Process... 18 Annex 1: Recommended Scope of DFID Good Practice Principles & Benchmarks... 20 Annex 2: Suggested Questions to Assess Credible Programme of Improvement... 26 Annex 3: Anti-Corruption Diagnostic Tools... 29 Annex 4: Main PFMA Diagnostic Tools... 30 Annex 5: PEFA... 32 Annex 6: OECD DAC... 34 Definitions What is fiduciary risk? Fiduciary risk can be defined as the risk that funds: are not used for the intended purposes do not achieve value for money are not properly accounted for 9. DFID s Accounting Officer is accountable to Parliament for how UK taxpayers funds under her/his control are used. This includes providing appropriate assurances that fiduciary requirements are met, so that public funds are used for the intended purposes, deliver value for money and are properly accounted for. Page 4 of 34

10. Fiduciary risk is the measure of uncertainty as to whether these fiduciary requirements are actually met, and is the combination of both likelihood and impact. The fact that risk management is about addressing uncertainty means that all decisions will involve judgement and depend on specific country circumstances. 11. Once funds are granted to a partner government for PRBS, DFID is not directly responsible for the use of those funds, since this responsibility is passed to the partner government. It is therefore critical that DFID is able to make an informed judgement of fiduciary risk related to partner countries PFMA systems and the governance and institutional context in which these systems function. This includes an evaluation of how the risk of corruption impacts PFMA performance. 12. Fiduciary risk is a risk for many stakeholders not just donors, and likewise applies to all partner government funds not just funds provided by donors. Both donors and partner governments are accountable to their own electorates for the propriety of public finances. The best way to reduce overall fiduciary risk is to improve the operation of the entire PFMA system and related governance and institutional arrangements. Donors should seek to promote and support the management of fiduciary risk by partner government themselves. Where possible, partner governments should be fully involved in fiduciary risk assessments and lead reform programmes. 13. The assessment of fiduciary risk is only one factor to be taken in to account when judging whether the potential developmental benefits of providing PRBS justify the risk. This note does not address developmental benefits, but will complement further guidance to be developed by the Aid Effectiveness team in Policy Division. The DFID Policy Note on Poverty Reduction Budget Support outlines some of the benefits and risks based on our initial experience. How do we define partner country PFMA systems? 14. Public financial management and accountability (PFMA) systems refer to systems and processes of budget formulation, budget execution, accounting and reporting, audit and related accountability mechanisms, covering both expenditure and revenue. Accountability mechanisms require governments to demonstrate the appropriate use of public funds for service delivery through transparent systems and processes, usually achieved through effective performance monitoring and independent scrutiny. Procurement is an integral part of PFMA systems and should be addressed as such throughout the fiduciary risk assessment. 15. Partner country PFMA systems refer primarily to central government systems, notably those of the Ministry of Finance / Planning and sector ministries, and systems of accountability outside the executive, notably those of the Supreme Audit Institution and Parliament (e.g. Public Accounts Committee). Where appropriate, consideration should also be given to sub-national government (e.g. Local Authorities) and other government spending agencies (e.g. State Owned Enterprises). Page 5 of 34

Evaluation 16. Once funds have been granted to a partner government for PRBS, DFID is not directly responsible for the use of those funds but should make a sound assessment of the effectiveness of the partner government s systems. This should include a thorough evaluation of its PFMA systems, including procurement, and associated risks (including the risk of corruption), and requires a sound understanding of the governance and institutional context in which these systems actually function. 17. When considering the composition of the team to complete a fiduciary risk assessment, it is recommended this should include strong knowledge of the country context, adequate financial management expertise, including knowledge of procurement and anti-corruption, and strong contacts with the partner government and donors (where not directly involved themselves). Early consultation with the DFID central support and scrutiny process is also recommended. Harmonised Approaches 18. To promote a harmonised approach DFID country offices should proactively engage in dialogue with partners (government, civil society and other donors) and where possible encourage fiduciary risk assessments to be carried out as a joint exercise building on partner government s own assessment. Where partners have already conducted a fiduciary risk assessment which meets the required standard, DFID should use that analysis as the basis for its own judgement. 19. The Public Expenditure Working Group comprising the World Bank, IMF and PEFA Program (Public Expenditure and Financial Accountability Program - see Annex 5) are currently working to develop a common PFMA Performance Measurement Framework to better enable a harmonised approach. This will include a standardised Performance Report based on an international set of PFM Performance Indicators. DFID promotes the future adoption of this framework and intends to supplement and evolve its own policy on managing fiduciary accordingly. 20. Pending finalisation of a common PFMA Performance Measurement Framework, fiduciary risk assessments should use the 8 good practice principles and 15 related benchmarks set out in the current DFID policy (see Annex 1). 21. DFID also participates on the Development Assistance Committee (DAC) of the OECD, to promote the harmonisation of donor practices for effective aid delivery. Annex 6 provides a more detailed summary of recently completed DAC work in relation to PFMA. Page 6 of 34

What information is required? Identification of Key Fiduciary Risks 22. Potential key fiduciary risks should be identified at the outset of the evaluation to ensure that the fiduciary risk assessment is effectively targeted and prioritised. To assist this judgement it will be useful to consider what factors constrain the achievement of desired PFMA improvements and to identify major items of revenue and expenditure, as discussed in Box 1. Box 1: Ways to identify priority fiduciary risks 1. Achieving improvements - it is important to understand the agreed goals or vision for improved PFMA. This should be a central component of a government led credible programme of improvement where do we want to get to? and should be defined in terms of agreed outcomes. 2. Major budgetary items it is also important to understand what the current composition of the budget is, in terms of identifying where most funds are spent and the main sources of revenue. This enables the risk assessment to prioritise material aspects of the budget in absolute terms. 3. Prioritised risks can then be assessed by considering: - whether or not they pose significant obstacles to achieving the agreed improvements - whether they relate to a significant item of revenue or expense - the related impact and likelihood of these considerations For example, if 80% of the recurrent budget relates to personal emoluments, key risks identified in payroll systems may be prioritised other notable examples may include risks relating to large expenditure on procurement, large funds transferred to State Owned Enterprises, significant decentralisation of resources to Sub-National Governments and major sources of revenue such as oil revenues. DFID Good Practice Principles & Benchmarks 23. Annex 1 details the 8 good practice principles and 15 related benchmarks defined in the current DFID policy as the basis for carrying out a fiduciary risk assessment. Further guidance has been included in the form of suggested questions for consideration. This guidance promotes a better understanding of the governance and institutional context, and addresses issues related to corruption. This guidance has drawn from the draft set of 28 PFM Performance Indicators being developed through the Public Expenditure Working Group (Annex 5). 24. The suggested questions in Annex 1 are not intended as a checklist and the extent to which they are relevant to a specific country will depend on context. Conversely, the benchmarks and suggested questions are not necessarily exhaustive, and may be expanded to take account of Page 7 of 34

specific country circumstances (for example, in response to participating in a joint donorgovernment exercise). Governance and Institutional Context 25. Understanding the historical, governance and institutional context of partner governments PFMA systems and processes is critical for effective evaluation. A thorough analysis of how these systems actually work requires an evaluation of both formal and informal structures. This information will enable a more informed assessment of the credibility of PFMA reform programmes and whether or not there is a positive trajectory of change. Understanding the dynamics of power underpinning PFMA processes can inform more effective support by reinforcing incentives for accountability and transparency. 26. DFID Policy Division is currently working with a number of country offices to develop tools to better understand the political economy of budget processes, which will serve to complement this note. This work is being taken forward jointly by the Drivers of Change and PFMA teams. Corruption 27. The fiduciary risk assessment must include an explicit statement on how the risk of corruption impacts the performance of PFMA systems, and whether related reforms (including anti-corruption reforms) represent a credible programme of improvement. 28. Since corruption can occur at many points in the PFMA system, the evaluation of such risk should be an integral part of the fiduciary risk assessment and should therefore be considered against the overall good practice principles (see Annex 1). 29. In addition to the regular information sources for evaluating PFMA systems and processes, the fiduciary risk assessment should review existing anti-corruption diagnostic results and related anti-corruption reform initiatives. Annex 3 provides examples of anti-corruption tools that may be available at the country level. 30. Key risks of corruption in relation to PFMA systems may include those directly related to internal control systems (e.g. lack of bank reconciliations), those related to the real operation of formal systems (e.g. ineffective external audit / tender board) and risks related to the wider governance and institutional context (e.g. judicial weakness). Key areas of the PFMA system prone to corruption include procurement, payroll and revenue collection. 31. Although a specific statement on the risk of corruption is required in the fiduciary risk assessment summary (see Table 4), how the detail of this risk is presented should be decided on a country-by country basis. This may be either as part of the overall fiduciary risk matrix or as a separate section. The important point is that an explicit statement is made prominent in the summary to adequately inform decision-makers. Page 8 of 34

Where is information obtained from? 32. To alleviate the burden on partner governments and reduce their transaction costs, the fiduciary risk assessment should, wherever possible, draw on existing information and diagnostic studies. Further in-depth diagnostic work should only be considered on an exceptional basis through a joint consultation process. 33. An example of where further diagnostic work may be necessary is procurement practices, especially where a comprehensive Country Procurement Assessment Review (CPAR) has not been carried out. Failure by partner governments to obtain value for money from their procurement systems is one of the major PRBS fiduciary risks. Further procurement advice and expertise can be obtained in DFID through contacting the PFMA team in Policy Division. Partner countries analysis 34. Wherever possible, donors should use partner countries analysis for fiduciary risk assessments. This is recommended in order to improve government capacity, increase accountability and enable effective donor harmonisation. Examples of this type of analysis include: Audit reports (including Value for Money audits) Public Accounts Committee reports and response of the Executive National Public Accounts Service Delivery Surveys Budget Execution Reports & Financial Tracking studies Public Expenditure Tracking Surveys Poverty Reduction Strategy (PRS) Progress Reports 35. The depth and reliability of this information will depend on a number of factors, including the quality of PFMA systems and related capacity. There may be conflicts of interest when information provided by government is used to make decisions on the provision of aid. This may be a particular problem where information is provided on the risk of corruption. The donor group should assess the integrity of information and ensure that corroborative evidence is obtained from sources independent of government, if necessary. Ensuring that information is consistent across different sources and different time periods will help to achieve this. Main PFMA diagnostic tools 36. There are six main diagnostic tools that are used in the assessment of PFMA systems as summarised in Table 2. Annex 4 provides further information on each tool indicating which of the DFID good practice principles they cover. Page 9 of 34

Table 2: Main PFMA Diagnostic Tools 1 PER World Bank Public Expenditure Review 2 CFAA World Bank Country Financial Accountability Assessment 3 CPAR World Bank Country Procurement Assessment Review 4 Fiscal ROSC IMF Report on the Observance of Standards and Codes of Fiscal Transparency 5 HIPC AAP World Bank / IMF Public Expenditure Tracking Assessments and Action Plans for Heavily Indebted Poor Countries 6 EC Audits European Commission Audits 37. To ensure the fiduciary risk assessment is comprehensive, the evaluation should consider findings from all main PFMA diagnostic studies already undertaken. A thorough assessment should seek to highlight any gaps in available diagnostic information (not covered by other sources of information) and should provide an indication of future diagnostic work planned. 38. A useful source for diagnostic information is the Country Analytical Work Website at http://www.countryanalyticwork.net. The Country Analytical Work partnership pools together a large group of multilateral and bilateral development agencies (including the World Bank, IMF, EC and DFID) in order to share knowledge and facilitate coordination and cooperation among partner countries and donors. NGOs, Civil Society Organisations and Media 39. Where appropriate, evaluations should take in to account the views of other actors such as Non-Governmental Organisations (NGOs), Civil Society Organisations, professional associations (e.g. accountancy bodies) and media sources. Existing diagnostic studies may have already engaged these actors, for example through Public Expenditure and Institutional Reviews or Public Expenditure Tracking Surveys. 40. Using a broad range of information is important to ensure wider participation in the analysis and monitoring of PFMA systems and associated risks (including corruption). This also promotes citizen voice and accountability and assists in providing a better understanding of the country context. A useful resource for further information is the International Budget Project of the Center on Budget and Policy Priorities at http://www.internationalbudget.org. Page 10 of 34

Credible Programme of Improvement 41. Following a thorough evaluation, the fiduciary risk assessment should provide a judgement as to whether the government has a credible programme to improve, and which risks can be managed by the adoption of appropriate safeguards. 42. The fiduciary risk assessment should provide an overall summary (or a map ) of PFMA reform initiatives including, where relevant, programmes such as Anti-Corruption reform, Public Sector Reform and Local Government reform. What is a credible programme to improve? 43. Box 2 highlights seven general features of a credible programme of improvement. Annex 2 provides further guidance with a set of related questions for consideration. This guidance is not exhaustive and is not designed as a checklist but rather provides a suggested framework to promote a consistent approach across country offices. 44. It is not expected that partner country reform programmes will meet all of these features. Recent experiences with PRBS submissions have highlighted particular weaknesses in features 1, 3 and 6, though any assessment will always be highly dependent on specific country context. What is important is that weaknesses within the reform programme are identified and explicitly stated for informed decision-making. Box 2: General Features of a Credible Programme to Improve: The programme to improve should: 1. be government led - enabling full political ownership and leading to effective harmonisation of donor interventions 2. be realistic and achievable - based primarily on available local capacity and set within an appropriate timeframe 3. integrate individual measures of improvement within a comprehensive framework which is effectively sequenced 4. be relevant and sustainable - adapted to the specific country context, targeted to meet key fiduciary risks and avoiding over-reliance on external technical assistance 5. focus on developing local capacity capacity development strategies should be a central component of the programme, considered from the outset of reform design 6. build demand for change - promoting a sustainable track record of improvement based on previous successes, to develop a momentum and impetus for change 7. include specific performance indicators with effective monitoring and evaluation against relevant targets and milestones Page 11 of 34

Which safeguards are appropriate for what risks? 45. The credible programme of improvement should provide an appropriate and sustainable response to identified PFMA weaknesses. Where specific high risks (risk rating C) have been identified, a judgement should be made as to whether these risks are effectively addressed in the programme of improvement, both in the long-term and the short-term. This should be explicitly stated in the fiduciary risk assessment. 46. Where high risks are not effectively addressed in the programme of improvement, specific short-term safeguards should be considered through dialogue with partner government and the donor group; or the fiduciary risk assessment should provide reasoned narrative as to why additional short-term safeguards are not deemed appropriate. This should be highlighted in the fiduciary risk assessment summary to adequately inform decision-making. Short-term Safeguards 47. There is no definitive list of which safeguards and measures are appropriate for what risks. Individual safeguards and measures for improvement may result in very different impacts depending on the specific context of their implementation. Recent research indicates that shortterm safeguards are often fragmented and ineffective in providing substantive fiduciary protection, especially in relation to Poverty Reduction Budget Support. A more holistic approach to PFMA reform should be considered, as exemplified by the platform approach (see Box 3). 48. In considering the appropriateness of short-term safeguards, care should be taken to avoid potential negative impacts on the PFMA system as a whole. For example, the promotion of parallel systems may undermine long-term systemic improvement, attract skilled staff away from essential government posts or create over-reliance on short-term external technical assistance. Box 3: A Platform Approach to PFMA Reform A recent study across 17 multilateral and bilateral agencies, commissioned through the PEFA Program (April 2003), concluded that short-term safeguards are often fragmented and ineffective in providing substantive fiduciary protection, especially in relation to Poverty Reduction Budget Support. The study recommends that fiduciary risk is best served through a platform approach whereby an appropriate and sustainable package of measures is designed to achieve increasing levels ( platforms ) of PFMA competence over a longer-term timeframe, with a strong focus on the importance of sequencing. An initial platform may focus on building effective dialogue, trust and integrity of basic data and should be defined in terms of improved outcomes, rather than individual short-term measures. The measures selected to achieve the defined outcomes will be dependent on specific country context. Page 12 of 34

For example, to reduce the scope for leakage, it may be more appropriate to improve basic internal controls for systems that already exist (e.g. improve existing payroll system) rather than implementing a brand new highly technical solution. Further guidance on this approach will be provided in the forthcoming PFMA Briefing Note A Platform Approach to PFMA Improvement How can risks be effectively monitored and progress evaluated? 49. Before entering into an agreement to provide PRBS, mechanisms for monitoring fiduciary risk and measuring progress in improving partner government PFMA systems should be agreed. (This should complement wider monitoring of progress against agreed poverty reduction targets.) The partner government should be able to demonstrate a clear track record of improvement over an agreed timeframe. 50. The frequency and extent of monitoring fiduciary risk should take account of specific country circumstances. These may include existing monitoring mechanisms, the degree of risk identified, the partner government s budget cycle and release of financial information, the timing of disbursement decisions and new diagnostic work undertaken. This should be explicitly stated in the fiduciary risk assessment. 51. Where possible, targets and milestones should be defined and agreed with reference to the key aspects of the partner government s own reform programme. Where there are existing mechanisms for the monitoring of progress in PFMA reform (such as through a Poverty Reduction Strategy review process), these should be utilised for the monitoring of fiduciary risk. Of prime importance is the shift away from narrow diagnostic assessment towards the monitoring of progress based on the partner government s own commitments and reform agenda. 52. Wherever possible, the main monitoring tools should be the partner country s own reports, especially those of the Supreme Audit Institution. This is recommended to enhance capacity development, increase accountability, and enable effective donor harmonisation of monitoring requirements. Where necessary, the quality and reliability of this information should be assessed with corroborative evidence from sources independent of the government. 53. The PFM Performance Indicators currently being developed through the Public Expenditure Working Group, will be a potential future vehicle for donors and partner government to agree a standardised framework for measuring improvements over time and assessing fiduciary risk in PRBS environments (see Annex 5). Page 13 of 34

Decision Making Audit Trail and Record of Information Sources 54. In accordance with DFID s accountability requirements, country offices must keep a complete audit trail of information relating to the assessment, management and monitoring of PRBS interventions. The fiduciary risk assessment should be explicitly recorded as part of this record. 55. A clear record should be kept of all information sources used in the fiduciary risk assessment, including partner country reports and findings from key diagnostic studies, noting when each report / study was performed and by whom. A summary of this information should be included as a bibliography in the fiduciary risk assessment. How should a Fiduciary Risk Assessment be recorded? 56. A fiduciary risk assessment, including an evaluation of the risk of corruption, should be included as a mandatory part of all PRBS submissions to inform decision-making and Ministers. Table 4 provides a recommended content for fiduciary risk assessments to facilitate comparability over time and strengthen consistency of approach across countries. Individual country contexts will determine the extent of content under each of the main areas. 57. Table 5 provides a recommended format for a fiduciary risk matrix to record detailed assessment against the 8 good practice principles and 15 related benchmarks and to be included as part of the overall fiduciary risk assessment. Quantifying Fiduciary Risk 58. DFID s 8 good practice principles and 15 related benchmarks provide a broad framework against which a thorough fiduciary risk assessment can be carried out (Annex 1 provides further guidance with a set of suggested questions for consideration). 59. The fiduciary risk matrix should include a risk rating using an A C scale for each of the 15 benchmarks. This rating should be applied on a conservative basis based on actual evidence obtained, rather than future prospects or intentions to improve. 60. The use of this rating scale should not be viewed as an exact science due to the complexity of specific country context and the fact that the benchmarks do not represent specific performance indicators. A detailed narrative against each of the benchmarks will always be of greater importance than the A C scale. For these reasons, there are no explicit criteria determined for the A C ratings, though it is important to ensure there is consistency between the narrative and related benchmark rating. Page 14 of 34

Table 3: Risk Rating Risk Rating A B C Detail Low risk - Represents a situation where there is basic compliance, although coverage may not be 100% Medium Risk - Indicates there are some significant weaknesses in compliance or that procedures need to be changed High Risk - Indicates substantial failure to comply or that the system will require substantial upgrading to meet the standard 61. To assist in recording the trajectory of change, an arrow should also be employed against each of the 15 benchmarks. This should indicate the expected progress going forward based on actual evidence of progress achieved to date. Positive progress No change Negative progress Overall Rating for Fiduciary Risk 62. An overall rating for fiduciary risk should be determined using a high / medium / low scale, for inclusion in the fiduciary risk assessment summary. Again, there is no specific formula to translate the 15 benchmark ratings into an overall rating, since specific country contexts will place different priority on different aspects of risk. This judgement will be assisted by a re-evaluation of the key fiduciary risks (see Box 1), and should give consideration to both the likelihood and impact of risks. Table 4: Fiduciary Risk Assessment Recommended Content Content 1 Overall Fiduciary Risk Assessment - Summary Detail Overall fiduciary risk: high / medium / low Summary of key areas of risk identified and related measures / reform to mitigate risks Statement on the risk of corruption Statement on whether there is credible programme to improve (is there a positive trajectory of change?) Bibliography of information sources Page 15 of 34

Content Detail 2 Monitoring Fiduciary Risk Outline of how fiduciary risk / PFMA improvement will be monitored over the next period Identify any performance indicators, conditionality or dialogue issues to be monitored 3 Fiduciary Risk Matrix (see Table 5) 4 Credible Programme to Improve 5 PFMA historical, political and institutional context Narrative and related risk rating (A-C) against each of DFID s 15 benchmarks Key areas of risk identified (including risk of corruption) and related measures / reform to mitigate risk where appropriate Indication of progress made to date against each benchmark, and expected progress going forward Summary of current PFMA reform initiatives and other related reforms, where relevant (e.g. Anti-Corruption, Public Sector reform, Local Government reform) Indication of key objectives, how they are managed and related timelines Assessment of overall programme to improve (considering the 7 recommended features where appropriate) Short background detailing PFMA historical, political and institutional context - key drivers of PFMA reform 63. The actual presentation of this information will be determined by the individual country context, especially where the fiduciary risk assessment is performed as a joint exercise. To promote a consistent approach to presentation for informed decision-making, it is recommended that heading 1 Overall Fiduciary Risk Assessment Summary is always made explicitly clear both in the fiduciary risk assessment and the main PRBS submission. Page 16 of 34

Table 5: Fiduciary Risk Matrix Good Practice Principle 1. A clear set of rules governs the budget process 2. The budget is comprehensive Etc Benchmarks for Assessment 1. A budget law specifying fiscal management responsibilities is in operation 2. Accounting policies and account code classifications are published and applied 3. All general government activities are included in the budget 4. Extra budgetary expenditure is not material Etc Rating A-C A B C C Trajectory of Change Overall Assessment (including key risks, measures / reform to mitigate risks, progress to date and expected progress may also include further detail on credible programme to improve, risk of corruption, and governance and institutional context) Page 17 of 34

Central Support & Scrutiny Process 64. To provide assurance to DFID s Accounting Officer and Ministers, and to strengthen consistency and lesson learning across DFID, fiduciary risk assessments will be subject to a central support and scrutiny process led by Finance and Corporate Performance Division (FCPD). 65. Programme Guidance Group (PGG) will act as the point of contact for spending divisions and will be responsible for assuring that the coverage of the fiduciary risk assessment complies with the operational guidelines set out in this How to Note. Specifically, PGG will review the assessment against the recommended content and will respond to spending divisions on any apparent omissions. 66. PGG will consult Policy Division (PD) teams (notably PFMA, Anti-Corruption and Aid Effectiveness) to review the analysis of the fiduciary risk assessment, including evidence in support of risk ratings given and overall judgements made. PGG will additionally consult with Internal Audit Division (IAD), on the basis that IAD will review each assessment and comment only where they have concerns (IAD will continue to cover the wider range of issues related to audit for project and programme proposals). 67. The central support and scrutiny process will be performed on the basis of information provided in the fiduciary risk assessment with the key objective to assure that judgements are explicitly presented and consistent with reasonable evidence. This process does not seek to undermine existing decision-making processes, and responsibility for judgements presented will remain with the relevant spending division. 68. Key questions to be considered by this process include: Is there an explicit judgement made on the overall level of fiduciary risk (high/medium/low)? Are key fiduciary risks identified with an assessment of whether related reform measures provide appropriate safeguards? Is there an explicit statement on the risk of corruption? Is there an explicit statement on whether there is a credible programme to improve PFMA (is there a positive trajectory of change)? Does the detailed narrative and related risk ratings provide reasonable and consistent evidence for judgements made? Is there a clear outline of how fiduciary risk / PFMA improvement will be monitored over time? Page 18 of 34

69. Based upon the advice received, PGG will ask that the covering submission for the PRBS proposal should note that either: FCPD has been consulted and is satisfied that the fiduciary risk assessment has been carried out in accordance with current DFID policy and operational guidance and that related judgements are explicitly presented and consistent with reasonable evidence. or FCPD has been consulted and has raised the following issues (to be set out) 70. The central support and scrutiny process is intended to be light and proportionate to risk. The extent of analysis required for each fiduciary risk assessment will be judged on a case-by-case basis and will depend on a number of factors. This will include the experience of each DFID office in providing PRBS and the extent to which country offices have consulted with both FCPD and PD in performing the assessment. Further guidance on how this judgement is made will be considered as the central support and scrutiny process beds in and capacity requirements become better known. 71. Consultation with FCPD and PD teams early in the development of PRBS proposals, as fiduciary risk issues are considered, is encouraged. This should include consultation during the preparation of related Project Concept Notes (PCN), in line with existing office instructions. When forwarding fiduciary risk assessments for central review, spending divisions should include a statement of the consultation process undertaken, in relation to both the fiduciary risk assessment and the wider PRBS proposal. 72. Where the case for PRBS involves acceptance of a particularly high level of fiduciary risk specific approval should be sought from DFID s Accounting Officer. Page 19 of 34

Annex 1: Recommended Scope of DFID Good Practice Principles & Benchmarks This guidance has drawn from the current draft set of 28 PFM Performance Indicators being developed through the Public Expenditure Working Group; this is not necessarily exhaustive and is not intended as a checklist. 8 Good Practice Principles (GPP) & 15 Benchmarks Suggested Questions to Consider GPP 1 - A clear set of rules governs the budget process 1. A budget law specifying fiscal management responsibilities is in operation Is the budget law of adequate quality to satisfy requirements on government to be fully accountable for the use of public funds? (This should inter alia provide for an effective macroeconomic framework, budget process and independent scrutiny process, with clearly defined roles and responsibilities.) Is there an effective budget circular with related budget guidelines and procedures on budget preparation and execution? Are the budget law, guidelines and procedures actually understood and implemented? Is there an effective legislative committee (e.g. Budget Committee) that examines the annual budget law and related budget appropriations? Does the scope of legislative review cover fiscal policies and the medium term fiscal framework in advance of revenue and expenditure details? Does the legislative committee have adequate capacity to effectively perform its role (for example does it receive timely, prioritised, user-friendly budget reports and have adequate resources for in-depth review)? Is the budget law passed before the financial year commences? 2. Accounting policies and account code classifications are published and applied Is there effective classification of the budget in relation to administrative / economic / functional / programmatic classifications? Are standard international classification practices applied (e.g. UN-supported Classification of Functions of Government COFOG)? Is the classification system understood throughout government and actually implemented on a consistent basis? (Inconsistent classification distorts allocations and reduces transparency). Page 20 of 34

8 Good Practice Principles (GPP) & 15 Benchmarks Suggested Questions to Consider GPP 2 The budget is comprehensive 3. All general government activities are included in the budget 4. Extra budgetary expenditure is not material To what extent does the budget include all significant expenditures on government activities, including sub-national governments, state-owned enterprises and activities funded by donors? Is adequate financial information provided by donors on all significant funding / assistance in a timely manner? How close are the actual funds provided to forecasts (predictability of donor funding)? Is there effective coordination of budgeting for recurrent and investment expenditures? Is key fiscal information (including annual budget reports, procurement information and audit reports) officially published and readily accessible to the public, in a user-friendly format? To what extent are different revenue streams actually captured on budget? This is a key area of corruption risk, for example through unrecorded tax collection, or natural resource concessions. GPP 3 The budget supports pro-poor strategies 5. Budget allocations are broadly consistent with any medium term expenditure plans for the sector or for the overall budget Is there a consistent multi-year perspective in fiscal planning, expenditure policy-making and budgeting? Are there costed statements of national and major sector strategies to guide the development of forward estimates? To what extent are forward estimates integrated in the annual budget formulation process? Is there strong direction in the budget circular regarding multi-year forecasts to be adhered to in budget submissions? To what extent can poverty related expenditure be identified in the budget (for example, through a comprehensive classification system or specific appropriations)? Is there evidence available to demonstrate that government expenditure is in accordance with agreed plans and supports the Poverty Reduction Strategy and Medium Term Expenditure Framework? Is there effective participation in the budget process by spending ministries? Are budget allocations and related strategy documents available as public documents? Page 21 of 34

8 Good Practice Principles (GPP) & 15 Benchmarks Suggested Questions to Consider GPP 4 The budget is a reliable guide to actual expenditure 6. Budget outturn shows a high level of consistency with the budget To what extent does the actual fiscal deficit deviate from budget? What has been the trend over the last three years? Is there a mid-year review process to update the revenue forecast and adjust related expenditure to maintain fiscal balance? To what extent does actual expenditure deviate from budget? What has been the trend over the last three years? Are there any notable trends across administrative (e.g. line ministry / spending agency) or functional (e.g. health / education) classifications? Are there any significant expenditure arrears? To what extent does actual revenue deviate from budget? What has been the trend over the last three years? Are line ministries and spending agencies able to plan and commit expenditures in accordance with the budget? (This requires funds to be made available by the Ministry of Finance in a predictable and transparent manner.) Do budgeted resources reach front line service delivery units in a timely and transparent manner? (Evidence of this may be obtained through Public Expenditure Tracking Surveys, which may also identify areas of leakage and hence corruption risk). GPP 5 Expenditure within the year is controlled 7. In-year reporting of actual expenditure Is there a relevant internal control system, which is cost effective, well-understood and complied with, for which senior management takes full responsibility? Is there regular and adequate review of the internal control system through an effective internal audit function? Is there reporting of error rates in procurement and expenditure transactions? Are findings used by the Supreme Audit Institution (external audit) and follow up action taken by management? Are there effective payroll controls? Are payroll records reconciled to human resource records ( the nominal roll )? Is there a strong system of payroll audit to identify control weaknesses and/or ghost workers? 8. Systems operating to control virement, commitments and Are virements ( re-allocations within the budget ) performed in an open and transparent manner in line with agreed procedures? Do virements reduce the effectiveness of the budget as a tool for Page 22 of 34

8 Good Practice Principles (GPP) & 15 Benchmarks arrears Suggested Questions to Consider effective planning and predictable funding? What are the political and economic interests influencing virements? Is there effective cash flow planning, management and monitoring? Is there a daily calculation and consolidation of cash balances? Is borrowing planned on the basis of reliable cash forecasts? Is there a single treasury account? Is there proper recording and reporting of government debt and guarantees? Are all guarantees approved by the Ministry of Finance against transparent criteria? Is there regular and sustainable analysis of debt sustainability? GPP 6 Government carries out procurement in line with principles of value for money and transparency 9. Appropriate use of competitive tendering rules and decisionmaking is recorded and auditable 10. Effective action taken to identify and eliminate corruption The risk of corruption associated with procurement is potentially high. This should be taken into account when considering the following questions. Is the procurement system defined by a clear regulatory framework which is consistently implemented under the oversight of both internal and external control systems? Are regulatory institutions and procedures adequately resourced (e.g. tender board)? Are contracts awarded on the basis of competition and value for money in accordance with the regulatory framework? Are controls in place to prevent conflict of interest in the award of contracts? Is there regular advertisement of procurement opportunities and publication of data on public contracts and awards? Are contracts awarded and payments made on a timely and transparent basis? Are records maintained and accessible? Is there a functioning independent appeals process? Do bidders have recourse to independent judiciary? Where procurement risk is judged to be significant, more in depth analysis may be necessary (DFID is currently working with the Joint OECD-DAC / World Bank Roundtable on Strengthening Procurement Capacities to further develop work in this area, including the development of a specific set of procurement benchmarks to underpin the related PFM Performance Indicator - contact the PFMA team for more information). Page 23 of 34

8 Good Practice Principles (GPP) & 15 Benchmarks Suggested Questions to Consider GPP 7 Reporting of expenditure is timely and accurate 11. Reconciliation of fiscal and bank records is carried out on a routine basis 12. Audited annual accounts are submitted to parliament within the statutory period Are timely and frequent bank reconciliations performed (reconciling government accounting records with bank statements held by central and commercial banks)? Are there any large differences left unexplained? Is there an effective process to investigate discrepancies with subsequent follow up by senior management? Are suspense accounts and advance accounts routinely reconciled and cleared? Regular and effective bank reconciliations are a key internal control to minimise the risk of corruption or misuse of funds. Even where formal internal controls are in place, corruption remains a risk if they are not applied in practice. Are budget reports disseminated within government on a timely and regular basis? Do these reports provide adequate classification that allows direct comparison of actual performance to budget, and which incorporates expenditure, revenue and debt information? Is there an effective two-way flow of information between the Ministry of Finance and spending units (e.g. line ministries and subnational governments)? Are the financial statements comprehensive and understandable, and prepared in a timely manner in line with the legislative framework? Are the financial statements prepared in line with recognised national / international accounting standards? Are the financial statements presented to the Supreme Audit Institution (external auditor) / legislature on a timely basis? The more time elapses before accounts are compiled and audited the more difficult it becomes to investigate and identify cases of corruption. GPP 8 There is effective independent scrutiny of government expenditure 13. Government accounts are independently audited Is the Supreme Audit Institution (external auditor) adequately resourced and empowered to perform its role effectively? Is the Supreme Audit Institution independent from the executive? This includes consideration of independence in relation to resource allocations and the scope and nature of audit work performed, in addition to the independence of individuals within the institution (e.g. Page 24 of 34

8 Good Practice Principles (GPP) & 15 Benchmarks 14. Government agencies are held to account for mismanagement 15. Criticisms and recommendations made by the auditors are followed up Suggested Questions to Consider Auditor General). Does the scope of external audit include all major entities in the public sector? Does the nature of the external audit work cover the full range of financial audit, including reliability of financial statements, regularity of transactions and functioning of internal control and procurement systems? Does the Supreme Audit Institution (external auditor) adhere to appropriate auditing standards (e.g. INTOSAI, IFAC) and focus on significant and systemic issues in its reports? An independent audit is an important means to prevent and detect corruption. A systems-based audit can be more useful than a transactions-based approach in identifying weaknesses in the internal control system, which may facilitate corruption. Is there effective follow-up of external audit findings by the executive (e.g. Ministry of Finance and/or individual audited entity)? This may be evidenced by a formal response to how the audit findings are being addressed and the timely reduction in un-cleared findings. Is there an effective legislative committee (e.g. Public Accounts Committee - PAC) that examines the external audit reports and questions responsible parties about the findings and subsequent actions for follow up? Does the legislative committee have adequate capacity to effectively perform its role (for example does it receive timely, prioritised, user-friendly audit reports and have adequate resources, including technical skills, for in-depth review)? Is the legislative scrutiny conducted in a transparent manner open to the public and media? Is there freedom of information legislation and media freedom to facilitate access? Are controls in place to prevent conflicts of interest (e.g. asset declarations, whistleblower protection)? Do conflicts of interest undermine the independence of legislative scrutiny? Effective and transparent legislative scrutiny and follow-up are important to identify and manage the risk of corruption. Several other institutions may have responsibility for the investigation of and prosecution for corruption; for example civil service internal disciplinary procedures, separate anti-corruption entities and the police / judiciary. Page 25 of 34

Annex 2: Suggested Questions to Assess Credible Programme of Improvement This guidance is not intended as a checklist and relevance will be dependent on specific country context. General Features 1 Government led 2 Realistic and achievable Suggested Questions Are there clear goals (or a clear vision) set out by government for improved PFMA? Is there demonstrable political commitment to PFMA improvement? Is there engagement of parliament / cabinet in PFMA reform and related monitoring of progress? Is PFMA reform a priority in the Poverty Reduction Strategy and any related Performance Assessment Framework? Does government take the lead in developing and monitoring the PFMA reform programme? Is there an active steering group? Is there ownership of PFMA reform across different parts of government in addition to the Ministry of Finance, including line ministries, subnational government, parliament and the Supreme Audit Institution? Is there a champion of change for PFMA improvement with programme objectives built into their performance plan (positive incentives for change)? Is the government investing its own funds to support PFMA reform? Does the government play a leading role in diagnostic assessments, and view the results as important for their own purposes as well as to meet the requirements of donors? Is there effective donor harmonisation around PFMA reform initiatives? Has the government requested harmonised approaches from donors built around (strengthened) local systems? How will commitment to reform be affected by a change in government and / or key stakeholders? Are current local capacity strengths and weaknesses taken in to account in the PFMA reform programme design, including both formal and informal factors? Are human resource and institutional constraints assessed in conjunction with a broad human resource strategy and wider public sector reform? Does the PFMA reform programme promote appropriate technology in relation to current systems and capacity (especially in relation to Financial Page 26 of 34

General Features 3 Integrated and effectively sequenced 4 Relevant and sustainable 5 Includes capacity development strategies Suggested Questions Management Information Systems), or does it require skills and experience that are not available? Is the timeframe for improvement realistic? Is there flexibility in the timetable to enable the reform programme to respond to changing circumstances? (Achieving more effective institutions for PFMA involves very fundamental processes of social and political change that should be viewed as longterm goals). Are individual measures co-ordinated in a comprehensive reform framework? Are these measures complementary? Are individual measures self-contained or do they depend on other developments taking place? Does the reform programme take account of these dependencies? Is there a focus on getting the basics right before more complicated PFMA reform measures are undertaken? Has the reform programme given sufficient attention to the sequencing of individual measures? How far are other complimentary reform programmes taken in to account, such as public sector reform, anti-corruption reform, local government reform and public expenditure tracking surveys? Are specific country context issues taken in to account in the PFMA reform design process (such as historical, governance and institutional factors)? Does the PFMA reform programme address the key risks identified in the fiduciary risk evaluation (including risks related to corruption)? Is there adequate / over-reliance on external technical assistance? Are there sufficient capacities and incentives to make the reform programme self-sustaining? Will the reform measures in place compete for scarce resources and capacity required for more basic improvements? Does the reform programme build towards long-term systemic improvements in PFMA? Does the reform programme enable a comprehensive capacity development strategy, with consideration given to the individual, the organisational and the institutional/political levels? Is capacity development addressed across a wide range of stakeholders (including Ministry of Finance, line ministries, Sub-National Governments, Page 27 of 34

General Features 6 Builds demand for change 7 Specific performance indicators Suggested Questions Supreme Audit Institution and parliament)? Is there sufficient attention given to monitoring the effectiveness of capacity development initiatives? Does the programme of improvement build on current strengths and successes? Does it build on processes that people are familiar with? Does the reform programme take account of related institutional and motivational aspects to build demand for change? Do measures to reduce incentives for PFMA related corruption (e.g. poor pay, conflicts of interest) complement measures to reduce opportunities (e.g. internal controls) and increase constraints (e.g. effective judicial system)? Will the reform programme work to increase transparency and encourage demand for further improvement? Does the reform take account of existing wider demands for accountability and transparency? What is the likelihood that the programme of improvement will actually be implemented? Does the programme of improvement include specific and relevant performance indicators? Is there an agreed timeframe and process for effective monitoring and evaluation? Is there an effective review and reporting process in place? Is this process led by government and supported by a harmonised donor approach? Page 28 of 34

Annex 3: Anti-Corruption Diagnostic Tools Transparency International (TI) National Integrity Studies (NIS) provide an assessment of a country s key institutions dealing with corruption; this includes the executive, legislature, political-party financing, elections, auditor-general, judiciary, police and prosecution, public service, public procurement, local government, media and civil society. The studies map the formal architecture (laws and rules i.e. what should happen ) and then assess what actually happens in practice, highlighting deficiencies in the formal framework or its implementation, including an assessment of the government s anti-corruption strategy. More information can be obtained at: http://www.transparency.org World Bank Institute Governance and Corruption (GAC) diagnostics are in-depth surveys of households, firms and public officials, gathering information on vulnerabilities within a country s institutions. Fieldwork, analysis and recommendations for follow-up action are carried out involving stakeholders from government, civil society and private sector, with WBI technical assistance. The surveys aim to provide an initial benchmark of governance and public-sector performance, and permit subsequent monitoring. More information can be obtained at: http://www.worldbank.org/wbi/governance/capacitybuild/diagnostics.html#guide Other Sources of Information: There is a wide range of further surveys and diagnostic tools on anti-corruption, often performed at a local level, which may provide relevant information for a fiduciary risk assessment (e.g. national anti-corruption surveys, household and bribery surveys). A recent mapping exercise of this information has been performed for a number of countries in Africa ( Local Corruption Diagnostics and Measurement Tools Mapping Study, February 2004), and a similar exercise is to be performed for other regions; this report is available on the U4 Anti- Corruption Resource Centre at http://partner.u4.no Page 29 of 34

Annex 4: Main PFMA Diagnostic Tools The following table summarises the main diagnostic tools currently used in the assessment of PFMA systems, indicating which DFID Good Practice Principle they generally cover: Diagnostic Tool PER CFAA CPAR Detail & Good Practice Principles World Bank Public Expenditure Review The PER is the Bank s traditional tool for analysing public expenditure, originally designed to assess fiscal trends and resource allocations. In recent years, PERs have increasingly added budget systems, implementation and capacity development. The main emphasis is on the upstream phases of expenditure management, including the good practice principles: 1. A clear set of rules governs the budget process 2. The budget is comprehensive 3. The budget supports pro-poor strategies 4. The budget is a reliable guide to actual expenditure In practice, a good PER should not entirely neglect budget execution, accounting and financial controls, and thus there may be some overlap with the CFAA. Some PERs are also conducted with an institutional component, commonly referred to as Public Expenditure and Institutional Reviews (PEIR). World Bank Country Financial Accountability Assessment The CFAA is the Bank s main diagnostic tool for PFMA and is designed to provide information about the environment in which Bank funds may be disbursed, and therefore helps to ensure donor funds are used properly. It is not an audit of specific expenditure, nor does it provide a pass/fail assessment, but it does provide recommendations and action plans. The CFAA focuses on describing and analysing downstream financial management and controls, including the good practice principles: 5. Expenditure within the year is controlled 7. Reporting of expenditure is timely and accurate 8. There is effective independent scrutiny of expenditure Where available, the CFAA is often used as the key diagnostic tool. Though very useful, the CFAA is not generally intended to cover all of the risk areas associated with PRBS, particularly the upstream phases of financial management. World Bank Country Procurement Assessment Review The CPAR has evolved from assessing procurement arrangements for Bankfinanced projects to providing a comprehensive analysis of a country s procurement system, including an assessment of associated risks and a prioritised action plan, covering the good practice principle: 6. Procurement is transparent and represents value for money. Page 30 of 34

Diagnostic Tool Detail & Good Practice Principles Fiscal ROSC IMF Reports on the Observance of Standards and Codes of Fiscal Transparency The Fiscal ROSC describes a country s systems and procedures relative to the IMF s Code of Good Practices on Fiscal Transparency, and provides an assessment with prioritised recommendations for improvement. The code draws upon 4 key requirements for fiscal transparency: clear roles and responsibilities, full provision of information, open budget preparation and execution and assurances of integrity. The scope and coverage of Fiscal ROSCs are similar to CFAAs, with a focus on downstream financial management including the good practice principles: 5. Expenditure within the year is controlled 7. Reporting of expenditure is timely and accurate 8. There is effective independent scrutiny of expenditure HIPC AAP EC Audits World Bank / IMF Public Expenditure Tracking Assessments and Action Plans for Heavily Indebted Poor Countries HIPC AAPs were developed in 2000 to ensure resources freed by debt relief are used for poverty-reducing public expenditure, as additional real resources. Instead of assessing every aspect of PFMA, they take a systems approach: identifying important indicators (through 16 benchmarks) that reflect a systems overall capability and performance, resulting in HIPC action plans. 24 HIPC AAPs were finalised in 2001, with a review on progress in implementing action plans in 21 of the HIPCs presented to the World Bank and IMF boards in 2003. In late 2004 the Bank and IMF will deliver a thorough reassessment of HIPCs, following another round of comprehensive assessments starting in 2003. European Commission Audits Until recently the EC s assessment instrument consisted of ex-post audits to test whether its resources were used in line with financing agreements. For targeted budget support the audits were adjusted to recognise that such funding is subject to national budget rules and procedures, and therefore focuses more on the legal framework and procedures for budget execution including procurement and financial accountability and control. The EC has recently proposed a new approach based on both ex ante assessments and traditional ex post audits. This new approach will have broad coverage, though will rely on recent diagnostic work by the World Bank, IMF and other agencies, complimented and validated by EC audit compliance tests. Page 31 of 34

Annex 5: PEFA The Public Expenditure and Financial Accountability (PEFA) Program which started in December, 2001, is a 3- year programme jointly financed by the World Bank, the European Commission, DFID, the Swiss State Secretariat for Economic Affairs, the French Ministry of Foreign Affairs, the Royal Norwegian Ministry of Foreign Affairs, the International Monetary Fund and the Strategic Partnership with Africa. A Steering Committee, comprising members of these agencies, is managing the Programme, with a secretariat located in the World Bank in Washington, DC. PEFA Aims and Objectives PEFA aims to support integrated and harmonised approaches to assessment and reform in the field of public expenditure, procurement and financial accountability. The key objectives are to strengthen partner government and donor ability to: (i) diagnose the condition of country public expenditure, procurement and financial accountability systems, and (ii) develop a practical sequence of reform and capacity development actions. The main work of the PEFA Program is focused on defining a Strengthened Approach for PFM performance, which is currently being developed through a Public Expenditure Working Group with the World Bank and the IMF. Strengthened Approach The Strengthened Approach for PFM outlines 3 main elements (this note details the intended approach as at July 2004, though it should be noted this is still being developed): 1. a Country-led Strategy and a prioritised, sequenced action plan determining reform measures and analytical work to be undertaken, and support to be provided by donors; 2. a Co-ordinated Program of work by donors to support PFM institutional reform through policy dialogue, analytical support, technical assistance and funding. The programme of work is aligned behind the country-led strategy and the prioritised, sequenced action plan; 3. a common Performance Measurement Framework for tracking progress and measuring results over time. This framework will be used to meet information requirements of donors engaged in budget support and will include a PFM Performance Report based on an agreed set of high-level PFM Performance Indicators. Page 32 of 34

PFM Performance Report The proposed PFM Performance Report will enable donors to assess the performance of a country s PFM system, to make judgements of improvements over time and to inform decisions on aid modalities. This is intended to be a narrative report based on a set of PFM Performance Indicators to provide observable, empirical evidence. The sources of information would include existing diagnostic work done at country level (e.g. PER, CFAA, CPAR, government information) and be prepared through a collaborative process between donors, possibly based on government self-assessment, with external validation for credibility and objectivity. This has the potential to be a single, donor-agreed fiduciary assessment. The report will be updated periodically depending on country circumstances and should feed in to government-donor policy dialogue. The agreement of a PFM Performance Report is still under consideration through the continuing development of the proposed Strengthened Approach. A programme of consultation and pilot testing is currently being undertaken through the Public Expenditure Working Group. PFM Performance Indicators The proposed PFM Performance Indicators are a standard set of 28 high level indicators designed to provide a broad measure of PFM performance. These indicators expand on the 16 HIPC benchmarks, and are framed within a set of 6 critical PFM objectives. Each indicator is measured against a four point ordinal scale A D, with specific criteria identified for measurement against this scale, from A representing a high level stage of development and good international practice, to D representing a system that is substantially failing. In addition to indicators of country PFM performance, this framework also includes two indicators of donor practices that impact country PFM systems. Further testing of the indicator set is currently being performed through the Public Expenditure Working Group; this includes an examination of the appropriate number of indicators, whether the guidance is sufficiently focused and specific and whether the related balance and weighting is appropriate. For further information on the PEFA Program visit their website at http://www.pefa.org Page 33 of 34

Annex 6: OECD DAC DFID is currently working with the Development Assistance Committee (DAC) of the OECD to promote the harmonisation of donor practices for effective aid delivery. In 2003, the DAC agreed a set of guiding principles and good practices to guide donor behaviour, covering six key topics: 1. Framework for donor co-operation 2. Country analytic work and preparation of projects and programmes 3. Measuring performance in PFM 4. Reporting and monitoring 5. Financial Reporting and Auditing 6. Delegated Co-operation Measuring Performance in PFM Under the guiding principles for Measuring Performance in PFM, the DAC recommends that in diagnostic work: Partner country governments should be fully involved in and have ownership of diagnostic reviews Harmonised diagnostic reviews should alleviate the burden on partner countries Harmonisation does not mean standardisation; that is, each donor must decide what level of risk it accepts in providing funds, in relation to developmental benefits Diagnostic reviews should be responsive to country development context Diagnostic reviews should be conducted according to open and transparent processes Understanding the institutional and governance context; that is, reviews of PFM systems are not simply technical exercises and require a full understanding of the underlying governance arrangements and in performance measurement: The measurement framework needs to encompass the critical aspects of PFM, covering budget formulation, execution, reporting and review The measurement framework should encompass internationally agreed codes and standards Performance measures should be comprehensive without being excessively numerous While there is no single overall measure of PFM performance, it is necessary to avoid too many indicators For further information on the OECD DAC visit their website at http://www.oecd.org/wpeff This guidance is part of the Policy Division Info series. Ref no: PD Info 045. Crown copyright 2004. Any part of this publication may be freely reproduced providing the source is acknowledged. Page 34 of 34